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How to Lose an Energy War With Putin

Forget Glasnost, Mikhail Gorbachev and the arms race. What really broke the Soviet Union was the collapse of oil prices in the late 1980s. The late economist Yegor Gaidar, one of Boris Yeltsin’s prime ministers, wrote in 2007 that the empire’s fall could be traced back to Sept. 13, 1985, when Saudi Arabia, fed up with holding back supply to prop up prices, opened the spigots in a quest to recover lost market share. That day, he argued convincingly, was the beginning of the end.

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The USSR, pumping almost 12 million barrels a day, was the world’s largest producer at the time. Riyadh’s change in policy caused a price shock: Oil fell from about $25 a barrel to less than $10 in the months that followed, and stayed low for the rest of the decade, costing the Soviet economy $20 billion a year in lost revenue—“money without which the country simply could not survive, ” Gaidar wrote.

Russia is the world’s biggest oil producer again now (though Saudi Arabia is the biggest exporter) but its economy still depends heavily on selling energy. Oil and gas exports account for about half of Russia’s budget and about 30 percent of its GDP. This makes it vulnerable. If the West wanted to punish President Vladimir Putin for his land grab in Crimea, runs the argument, it should target the energy revenues that keep his petro-economy afloat.

In the short term, though, the West can’t devastate Russia’s energy sector—in which Western companies such as ExxonMobil, Shell, Total, Eni, Statoil, BP and GE are all heavily invested—without damaging itself. A longer-term option could involve efforts to deflate real oil and gas prices gradually, either by reducing growth in energy consumption or boosting supply. But that has made strategic and economic sense for decades and not much has changed. It’s hard to see Russia’s annexation of Crimea being the trigger for a fundamental shift in the global energy business.

One proposal is for the United States to sell off some its Strategic Petroleum Reserve (SPR) to cause an immediate fall in crude prices. At the last count, the SPR held 696 million barrels of oil in depots along the Gulf of Mexico. Energy expert Philip Verleger calculates that the United States could release between 500,000 to 750,000 barrels per day from it for two years without breaching international obligations to keep 90 days’ worth of equivalent oil imports in storage. Rising U.S. production has undermined the need for the SPR to hold so much oil. Sell off the excess, Verlager argues, and global oil prices would fall by $10-12 a barrel, costing Russia $40 billion in lost revenue and wiping 4 percent off its GDP.

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Would the United States do it? It recently agreed to sell 5 million barrels from the SPR, ostensibly for technical reasons, though the announcement was seen as a message to the Kremlin. One analyst quoted by Platts, an oil-price reporting agency, likened the move to “cleaning the shotgun on the porch when your daughter has a date coming over.”

But a bigger SPR release is risky. The stored oil is there for emergencies. The last release, in 2011, followed the collapse of exports from Libya during its civil war, and probably prevented a price spike. Selling some SPR oil now would leave the market wondering when the United States would next wield this energy weapon, and against which oily foe. The market’s reaction is unpredictable, too. Buyers might just hoard the extra oil, thinking the SPR had lost some capacity to handle a genuine supply interruption. Or China might use a dip in prices to beef up its own strategic reserve, which holds more than 160 million barrels now but will expand to 500 million by 2020.

And, really, how much of a threat to Russia is a $12-a-barrel price drop from historically high prices above $100? The United States couldn’t carry on releasing the oil indefinitely, so the Kremlin might just take the hit, adjust fiscal spending and knuckle down until America’s ploy had run its short course and prices rose back to their market level—assuming a hurricane, Middle East war or pipeline explosion hadn’t pushed prices up again in the interim anyway.

Derek Brower is editor-at-large of Petroleum Economist and a frequent contributor to The Economist. He lived in and reported from Russia in 2003 and 2005.